Restoring macroeconomic stability

The improved performance of the Papua New Guinean economy over the past year or so reflects in part a recovery in commodity prices and more favorable agricultural conditions. Importantly, however, it is also the result of sound macroeconomic management, including a tightening in fiscal policy and the prudent operation of monetary policy.

This year’s staff report emphasizes the importance of addressing the structural impediments to private sector growth. The Papua New Guinea government is fully aware of the reform challenges it faces and is making progress in tackling a sizeable structural reform agenda. However, no sustained advancement in lifting the economy’s growth potential is possible in the absence of macroeconomic stability. This was the focus at last year’s Article IV consultation, when Directors expressed concern over growing fiscal pressures and rising inflation. These concerns have been addressed and over the course of 2003 considerable progress has been made in restoring macroeconomic stability. The basic theme of the budget was “stabilization with growth”. The authorities should be commended for the significant policy advancements that have been made since the last consultation.

An improved economic performance

After three years of negative growth, real GDP is estimated to have increased by 2.7 percent in 2003 and further growth is forecast for 2004.

Inflation has fallen from 20 percent in the March Quarter 2003 to be currently around 3 percent.

International reserves have risen to over six months of non-oil imports and are now at their highest levels since the country gained independence.

The overall balance of payments moved from an estimated deficit of 2.2 percent of GDP in 2002 to a surplus of 2.8 percent in 2003.

Private sector employment rose by nearly 9 percent in the 12 months to June 2003, compared with just above 1 percent growth in the previous 12-month period.

There are also a number of promising forward indicators. The number of new petroleum licenses issued has grown from 1 in 2002 to 12 in 2003. In line with this, the number of new exploration wells has risen from 4 active wells in 2002 to 8 active wells by end-2003, and outlays on mining exploration doubled in 2003 compared with 2002. It is to be hoped that this resurgence in exploration, which is in part a response to incentives provided to the mining and petroleum sectors in 2003, will lead to new discoveries and production over the medium term.

Enhanced fiscal discipline

Underpinning this better performance have been significant improvements in fiscal management.

A number of factors complicated fiscal policy in 2003, including the shortfall in privatization proceeds and, importantly, donor flows, particularly the non-receipt of a US$35 million drawdown from an Asian Development Bank loan. This shortfall in external financing resulted in the government having to resort to higher domestic borrowing and the increased volume in Treasury Bills issued, along with tight monetary policies, saw Bill yields increase sharply. The resulting higher than budgeted interest rate expense imposed upward pressure on the budget deficit. As was noted by the Board during the 2003 Article IV consultations, firm action was required to bring the deficit back in line with targeted levels.

The authorities implemented the necessary forceful action with a decisive mid-year expenditure adjustment equivalent to 0.8 percent of GDP. The result was that the Budget was in overall balance during the second half of 2003 and the deficit was held at the originally budgeted target of 2 percent of GDP.

This sound approach to fiscal management has been continued into 2004, where the budgeted deficit is 1.5 percent of GDP. Importantly, the 2004 Budget is based around a medium-term strategy with the following key components:

• Reducing public debt to around 60 percent of GDP by 2007.

• Further reducing budget deficits over the period 2005 to 2007 and a balanced budget thereafter.

• Introducing improved governance and stringent controls on expenditure.

• Reallocating where possible increased expenditure so as to improve the range and quality of government services.

• Pursuing aggressive medium-term plans to promote growth in export-oriented sectors.

In presenting the 2004 Budget, the Minister for Finance and Treasury noted that the targeted reduction in the deficit in 2004 maintained the strategy of moving public finances onto a more sustainable basis. He emphasized, however, that it takes time to develop the necessary measures for effective control and rationalization of public expenditure. This includes the acknowledged need to address public sector employment. Significantly, following the input from the Public Expenditure Review and Rationalization Study which was prepared with the assistance of the World Bank, important new governance and expenditure control measures are being introduced. Personnel controls are receiving increased attention and the recruitment freeze on public sector positions has been maintained along with new restrictions on the recruitment of casual employees.

With time needed to fully implement the required tightening and prioritization of expenditure, the maintenance of sound fiscal policies places additional pressure on the revenue side of the accounts. The government is of the view, however, that the incidence of taxation in PNG is high by regional and international standards. It also considers it necessary to maintain a tax structure that would support private sector activity. As such, rather than increasing tax rates, the focus has been directed at improving the taxation administration system, although again this is an area where time is needed to reap the benefits of reforms.

Against this background, and in order to ensure continued progress in putting public finances on a more sustainable footing, the government introduced a temporary import levy in 2004 of 2 percent. In announcing this levy, the Minister for Finance and Treasury stated that “I very frankly would prefer not to have applied this temporary levy, but it has been found to be unavoidable to ensure fiscal responsibility throughout 2004 while our broader reforms are put in place”.

Papua New Guinea faces large net outflows in 2004 to cover payments to the Asian Development Bank, World Bank, IMF and an earlier bilateral loan payment to Australia. Ongoing large net outflows to major official lenders are an important medium-term challenge. In addressing this challenge, the government is pursuing a strategy of transferring Papua New Guinea from a country dependent on aid to one that is more self-reliant.

In the 2004 Budget, the government announced that against the background of large net outflows to official creditors, the government would consider small external commercial financing. Earlier this year, the government considered an international bond issue, although in a statement to Parliament on May 12, 2004, the Prime Minister announced that the government had deferred proceeding with the bond issue to allow further assessment of the prospects for the issue given market developments. In making this announcement, the Prime Minister emphasized that the government was only testing the market and would not proceed with the bond issue “..... and put the country into greater debt, with all the associated foreign exchange risks, if the market is not yet ready for us, and if we are unable to secure competitive terms”.

Prudent operation of monetary policy and strengthening the financial sector

The Bank of Papua New Guinea (BPNG) has implemented a prudent monetary policy stance which has contributed to the achievement of macroeconomic stability. Specifically, the BPNG has focused on the task of reducing inflation and maintaining the stability of the financial system. An excessively expansionary budget deficit in 2002 was countered by tight monetary policy. Greater fiscal discipline and the decline in inflation has allowed BPNG to lower the kina facility rate (the official rate used to indicate the central bank’s monetary stance) by 100 basis points on two occasions so far this year.

In the 2004 Budget speech, the Minister for Finance and Treasury reaffirmed the government’s commitment to the total independence of BPNG. The central bank has demonstrated its capacity to conduct an independent monetary policy and this has been a positive factor for investor confidence.

In terms of financial sector supervision, the financial position of the pension funds has been significantly improved under new regulatory arrangements. The Superannuation Act and Life Insurance Act has removed all political interference in the operation of pension funds and tightened regulatory oversight with BPNG tasked with administering the superannuation and life insurance acts.

Advancing structural reforms

As noted, the government fully recognizes the structural reform task it faces. It appreciates that the pace of economic activity will crucially depend on removing bureaucratic and infrastructure impediments to private sector investment, as well as addressing problems of law and order and enhancing overall governance arrangements. As the Minister for Finance and Treasury noted in his speech to the 2003 Bank/Fund Annual Meetings, the problems in terms of governance within Papua New Guinea do not stem from shortcomings with the system itself, but rather weakness in the accountability framework. These weaknesses are being addressed.

The government is rebuilding a public sector that is professional, has integrity and is committed. Steps have been taken to strengthen and de-politicize the appointment process in the public sector, re-orient personnel management systems, strengthen probity and oversight agencies, improve the delivery of major services, strengthen government procurement practices and procedures, improve debt management, liberalize investment and promote private sector participation and review and progress the privatization process to ensure that proper procedures are adopted and clear net benefits can be obtained.

Political stability is an essential ingredient in advancing reforms as well as boosting investor confidence. The introduction of the Integrity of Political Parties and Candidates Acts in 2002 was an important step in providing greater political stability in Papua New Guinea.

The staff state that the reform momentum has slowed this year because of political uncertainties, including the possibility that the government could face a no-confidence motion in parliament, given that the 18-month embargo on such motions following a general election has now passed. The government’s position has, however, recently been strengthened with a number of members of the opposition party joining the government.

My authorities would like to thank the Fund for the assistance Papua New Guinea has received, not only through the formal Article IV process, but also through frequent staff visits and valuable technical assistance.